Monday, March 2, 2009

Shortcuts on FCPA Due Diligence Today Will Be Costly Tomorrow

Guest Blogger, Sharie A. Brown of DLA Piper -

The current financial crisis and market volatility understandably focuses corporate executives and their employees on corporate survival and improved financial performance. In my experience, corporate consolidations, divestitures, restructurings, and employee layoffs create organizational distractions that can distort sound judgment and reward short-term, but ill-conceived business solutions. At a recent General Counsel Forum in Chicago last week focusing on fraud prevention and anticorruption strategies, the attendees from corporate legal departments and financial functions indicated that they will be required to operate with fewer compliance and internal controls resources. None of the attendees thought their companies will be more susceptible to fraud and corruption violations this year compared to other years. Yet, my observations over the years indicate that from late 2009 through 2012, we should expect to see several currently reputable, large U.S. companies and individual corporate managers under investigation for fraud, corruption, and other criminal and civil violations. These companies and individuals will face enforcement scrutiny because they did not fight the tendency of managers and business units to shortcut legal compliance, internal controls, and due diligence procedures designed to prevent and detect financial crimes, particularly violations of the US Foreign Corrupt Practices Act ("FCPA").

One of the most important FCPA compliance and internal controls involves the conduct of appropriate, risk-based due anticorruption diligence on third party intermediaries, agents and consultants, as well as overseas joint venture partners, and international merger and acquisition target companies in high risk countries and industries for public corruption. This risk-based approach requires companies to take into account the following factors, among others: i) the reputation of the party or agent for corruption in the industry; ii) the local country’s reported reputation for public corruption; iii) whether the party is the subject of local media scandal or enforcement scrutiny, or on any international governmental lists; iv) whether the acquiring company has industry contacts that have information about the targeted party; v) the apparent competence and qualifications of the party for the project or activity contemplated; vi) whether the party was referred by a foreign official; vii) the availability and reliability of information about the targeted party in public databases, websites, and business reporting services; viii) whether the party is a foreign government official within the meaning of the FCPA, and whether there is shareholding by a foreign official in the party ; ix) whether the party is an agency or instrumentality of a foreign government; and x) whether the party or its shareholders are a relative or close associate of a foreign government official. Appropriate FCPA anticorruption due diligence would take into account and address these issues.

A more rigorous due diligence is appropriate in situations where the third party relationship or target company acquisition is highly strategic and economic, but the public corruption risks for the country and the industry are well-documented. For this important high-risk acquisition or joint venture relationship, there is no substitute for an in-country review consisting of in-person interviews of the parties and their key personnel, as well as relevant document reviews and sampling by U.S. professionals who regularly apply U.S. FCPA standards, in consultation with local professionals, to ensure that local anticorruption, data protection, and related fraud laws and rules, are recognized. Yet, during times of tight corporate finances, some companies will forgo such FCPA due diligence in favor of database reviews only, or they will rely on background or financial investigators whose reports list "FCPA" in the report title, but unfortunately those reports do not recognize or actually examine high risk FCPA/anticorruption activities. These seemingly cost-effective due diligence shortcuts actually result in expensive FCPA legal exposure for the acquiring company due to the FCPA risk items overlooked or misunderstood by the background investigators.

U.S.enforcement agencies are watching companies, and seem more determined to ensure that FCPA compliance, and other and financial compliance requirements continue to be fulfilled during the financial crisis. The U.S. Securities and Exchange Commission ("SEC") Office of Compliance Inspections and Examinations issued a letter to CEOs of SEC-registered firms to remind them of the important role that compliance programs play in helping companies meet their obligations under the securities laws. The SEC emphasized that even with the current financial crisis, corporate cost cutting-measures should take into account the need to maintain adequate compliance programs and internal financial controls systems. See Lori Richards, Director, Office of Compliance Inspections and Examinations U.S. Securities and Exchange Commission, Open Letter to CEO's of SEC-Registered Firms (Dec. 2, 2008) (available here). Companies should consider this SEC notice to be an early indication that the financial crisis, standing alone, will not insulate a company against U.S. enforcement actions for fraud, FCPA violations, or other financial and reporting violations arising from a high risk environment created by the failure to maintain controls, or follow FCPA procedures, and test compliance systems.

Aggressive U.S. enforcement of financial fraud, corruption, and other criminal and civil violations is also forecast as a result of Congressional efforts with respect to the Supplemental Anti-Fraud Enforcement Markets Act ("SAFE Markets Act"). This anticipated legislation seeks to materially increase funding for investigative and prosecutorial resources by $110 million for enforcement actions involving financial fraud, corruption, ring the financial crisis may be particularly challenging for companies this year. Senator Charles E. Schumer (D-NY) and Senator Richard C. Shelby (R-Ala) of the Senate Banking Committee believe that 50 new assistant U.S. attorneys and 100 new SEC enforcement employees need to be hired to investigate and prosecute financial crimes.

Further, the U.S. Department of Justice ("DOJ") and the SEC are expected to continue aggressive investigation and enforcement of the FCPA, while imposing several millions (and possibly additional billions) of dollars in fines, penalties, and disgorgements for future violations. Thus, the lesson is clear: in the practice of FCPA due diligence for agents, joint venture partners, and merger and acquisition targets, a due diligence shortcut for savings, could ultimately become the most devastating and costly strategy for companies, managers, individual employees, and corporate boards under the FCPA.


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With respect to the SAFE Markets Act, I am skeptical that the country will see any meaningful increase in the number or quality of cases as a result of the Act itself. For example, the summary of the legislation in the press release suggests that the bill will provide for 50 new Assistant United States Attorneys at a cost of $10 million. If the salary for each AUSA is about $100,000, then it appears this may be another series of fifty two-year term AUSA positions. These short-term slots have been a favorite way for Congress, in recent years, to increase the number of AUSAs working in a particular area without committing to a permanent budget increase.

The problem is, white-collar prosecution is a long-term endeavor. Many investigations (and certainly the resulting prosecutions) are not begun and concluded in a two-year time frame. Moreover, although the rocky economy may change the hiring dynamic, the type of attorney interested in a limited-term stint as an AUSA is generally a mid-level associate at a large law firm. Those smart, driven individuals often have no prosecutorial experience and limited courtroom experience. They require at least several months to get “up to speed” on the techniques for the investigation and prosecution of criminal cases. By the time they have their feet wet, they are well into a two-year term, and generally turn their attention to applying for a permanent AUSA slot, which may or may not be available. Any cases they begin investigating during their tenure may have to be handed off to a permanent AUSA, if the term slots are not renewed.

The government would attract the most qualified and experienced applicants by creating additional permanent AUSA positions, even if there have to be fewer positions created. A temporary influx of short-timers may be effective in combating, for example, a spike in violent crime that can be addressed by a series of reactive prosecutions. However, the length and nature of white collar prosecution is not conducive to limited-term prosecutors, and that $10 million could be better spent elsewhere.

As you correctly noted, the legislation also creates a significant number of positions for FBI agents and SEC enforcement staffers. Certainly, the diversion of FBI resources to anti-terror efforts after 9/11 has contributed to a decline in the number of white-collar prosecutions. The creation of additional permanent agent positions will be a significant step towards investigating and prosecuting more white-collar offenders.

Posted by: Steve | Mar 3, 2009 9:29:25 AM

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